Professionals should shoulder their end of the tax load

by Joe Sullivan

Doctors and dentists, lawyers, accountants, architects, engineers, consultants and other providers of professional services make more money than most other classes of business in this state. According to the 1992 federal census of services, Tennessee providers of these services alone had receipts of close to $7 billion—and their yearly take has surely increased since then.

Yet hardly any of these professionals are subject to any of the several types of state taxes that most businesses pay. Sales taxes, excise taxes, franchise taxes, gross receipts taxes—you name it and somehow the privileged professionals are exempt from all of them.

At a time when the state is so strapped for revenue that even our heretofore parsimonious Gov. Don Sundquist is calling for a tax increase, allowing these fat cats to continue to throw the state goose eggs becomes intolerable.

Sundquist's proposed 2.5 percent tax on all business payrolls and profits at least puts a halt to all of the limited liability shell forms that professionals have contrived to avoid the state's present 6 percent excise tax on corporate profits. The payroll component is essential to prevent them from continuing to dodge taxes by treating all of their hefty fee income as salary expense and thus avoiding profits.

If Tennessee were among the 42 states with a personal income tax, all of these tax dodges would have been unavailing to begin with. Service providers could opt to pay their fair share of the state's revenue needs either through their business entities or individually, and the end result would be the same. But this straightforward solution to Tennessee's tax problems has been equally unavailing, given the electorate's income taxaphobia.

Notably, another state that takes perverse pride in its tax aversion—namely, New Hampshire—has recently opted for a tax on compensation that bears a lot of resemblance to what Sundquist has proposed for Tennessee. And the impetus was much the same: to keep service providers and other businesses from inequitably escaping New Hampshire's business profits tax.

The two landmark studies of Tennessee's tax structure conducted over the past quarter century have both pointed toward the same conclusion. A 1974 recommendation of the Tax Modernization and Reform Commission (which had been established in 1972 by the state legislature) was to, "Enact a general modified gross receipts tax on all business and professions and repeal the corporate franchise tax, the local business tax, and miscellaneous state gross receipts taxes. This recommendation is meant to provide some increase in intrastate tax equity and to simplify the business tax structure." In 1985, another two-year study, this one by a special joint legislative task force led to recommendations that included: (1) reduction in the sales tax rate; (2) a broad-based personal income tax; and (3) a single business tax in the nature of a value-added tax on all goods and services.

According to a 1997 study by the former research director of the state Department of Revenue, Stanley Chervin, the method for calculating the third of these recommendations "calls attention to the fact that in the case of many small businesses, especially professional businesses, such as lawyers, doctors, consultants, etc., value-added is primarily what the owner (or owners) earns from the business. It was this realization during deliberations of the Special Joint Legislative Task Force...that cooled what had been an initial interest and enthusiasm for the tax."

So there's really nothing new about Sundquist's tax proposal—and nothing new about the opposition it's drawing from lobbyists for small business and professionals. At least businesses that sell goods remain subject to sales and gross receipts taxes. But professionals, along with most of the rest of the ever-growing service sector of the economy, are exempt from these as well.

Of course, application of sales taxes to doctors' and dentists' bills would be would be every bit as regressive as their application to groceries, which Sundquist proposes to repeal. But as of the 1992 census, that still leaves upwards of $3 billion in legal, accounting, architectural, engineering, consulting and other professional service receipts on which a 6 percent state sales tax would yield around $200 million a year—half of the $400 million in what's euphemistically called revenue improvement that Sundquist is seeking.

The Tennessee Bar Association and other professionals have predictably lobbied against all prior attempts to infringe on their exemptions from sales and gross receipts taxes at both the state and local level. "When that's been mentioned, we've been against it because nobody wanted to be responsible for all the record keeping, collecting and remitting," says Gil Campbell, the TBA's longtime executive director.

Huh? Lawyers seem perfectly able to keep client billing records and—presumably—federal income tax records, so why should state tax bookkeeping be more difficult for them than any other class of business? In lieu of any other taxes, it is true that professionals each pay $200 a year to the state for what's aptly called a privilege tax. It's also true that none of the 42 states with an income tax subject professional fees to sales tax because of potential distortions—such as prompting clients to turn to firms outside the state for professional services in order to avoid the tax.

Extension of the sales tax probably represents a last resort to be imposed only if Sundquist's proposed tax on compensation fails. Many doctors, lawyers, and accountants in this columnist's acquaintanceship share his conviction that a state income tax is by far the best solution to Tennessee's fiscal and—by extension—its educational deficiencies. So this column is by no means intended to tar all professionals with the tax dodger brush. But they should all share a collective sense of embarrassment over failure to pay their fair share up to now.